Investor sentiment at highest level since Trumpflation trade

Trevor Greetham

10 January 2018

Investor sentiment has hit its highest level in almost a year, according to our indicator. A number of factors, including an eight year high in private investor bullishness and low equity market volatility have driven our weekly composite investor sentiment indicator well into euphoric territory.

With the Republican tax cut set to boost corporate profits in America, the key questions will be how long this investor euphoria about Donald Trump’s first substantive piece of legislation can be sustained, and whether this is “rational exuberance”?

The indicator has only produced readings this high just 5% of the time since 1991, but can sometimes remain at an elevated level for several months when there has been a development seen as positive for stocks. Previous sustained bouts of euphoria took place after the invasion of Iraq in 2003, during the aftermath of the global financial crisis in summer 2009 and after the election of Donald Trump in November 2016.

Despite the plethora of records being broken in equity markets and rising valuations, we still see a positive backdrop for stocks. After eight and a half years of economic expansion, global inflation remains muted, interest rates are low and tax cuts should boost US company profits. Interestingly, US company directors remain strong buyers of stock in their own companies, which is usually a good sign.

However, with investor sentiment so upbeat, we wouldn’t rule out a short-term setback. Possible triggers could be weaker data in China where policy has been tightening or a faster than expected rise in inflation and interest rates in the US.

If either of these events occur, we’d be likely to buy this dip. We think a slowdown in China would keep interest rates lower for longer, while a setback linked to US rate hikes would also be unlikely to herald the end of the bull market. With US interest rates still below the level of inflation and business confidence rising, it would take some time to rein in US growth, even if the US Federal Reserve were determined to do so.

FOCUS CHART – INVESTOR SENTIMENT & GLOBAL STOCK PRICES

Investor sentiment has hit its highest level in almost a year, according to our indicator. A number of factors, including an eight year high in private investor bullishness and low equity market volatility have driven our weekly composite investor sentiment indicator well into euphoric territory.

With the Republican tax cut set to boost corporate profits in America, the key questions will be how long this investor euphoria about Donald Trump’s first substantive piece of legislation can be sustained, and whether this is “rational exuberance”?

The indicator has only produced readings this high just 5% of the time since 1991, but can sometimes remain at an elevated level for several months when there has been a development seen as positive for stocks. Previous sustained bouts of euphoria took place after the invasion of Iraq in 2003, during the aftermath of the global financial crisis in summer 2009 and after the election of Donald Trump in November 2016.

Despite the plethora of records being broken in equity markets and rising valuations, we still see a positive backdrop for stocks. After eight and a half years of economic expansion, global inflation remains muted, interest rates are low and tax cuts should boost US company profits. Interestingly, US company directors remain strong buyers of stock in their own companies, which is usually a good sign.

However, with investor sentiment so upbeat, we wouldn’t rule out a short-term setback. Possible triggers could be weaker data in China where policy has been tightening or a faster than expected rise in inflation and interest rates in the US.

If either of these events occur, we’d be likely to buy this dip. We think a slowdown in China would keep interest rates lower for longer, while a setback linked to US rate hikes would also be unlikely to herald the end of the bull market. With US interest rates still below the level of inflation and business confidence rising, it would take some time to rein in US growth, even if the US Federal Reserve were determined to do so.

FOCUS CHART – INVESTOR SENTIMENT & GLOBAL STOCK PRICES

The value of investments and the income from them is not guaranteed and may go down as well as up and investors may not get back the amount originally invested. The views expressed are the author’s own and do not constitute investment advice.